Qualified dividends are regular dividends that meet certain requirements (as detailed below) and are then granted a lower capital gains tax rate.

Requirements

For a dividend to be classed as a qualified dividend it must conform to the following requirements:

• Be paid between January 1^st 2003 and December 31^st 2010
• Be paid by a US corporation
• The stock must have been held by the investor for 61 days.

To expand on point two, the stock must be paid by a US corporation. This requirement also includes companies that are incorporated under the ownership of another US corporation, a foreign company that is located in a country where certain US tax treaties apply or a foreign company that can be accessibly traded on a major US stock market. With reference to point three, the stock must be held for at least 61 days in the 120 day period that begins 60 days before the ex-dividend date, and ends 59 days after it.

Benefits

Meeting the requirements above allows the income gained from the dividend to be taxed under the long-term capital gains tax rate which is at a lower rate than the tax rate for ordinary income.

The rate upon which one is taxed on qualified dividends depends on their initial ordinary income tax rate bracket. In the period 2003-2007, the qualified dividends tax rate for those in the 10% to 15% ordinary income bracket was 5%, and for everyone in the 25% to 35% brackets, 15%. In 2008 this was revised meaning that people in the 10% to 15% ordinary income tax bracket now pay 0% on qualified dividend income; higher tax brackets are still eligible for the 15% rate. From 2011 onwards, the tax for qualified dividends will be the same as that for ordinary income, unless of course Congress extends the qualified dividend tax cuts prior to January 1^st 2011.

With the holding period set at 61 days, you can theoretically ‘rotate’ your capital around 6 different stocks, taking 6 dividends a year, all qualified and thus benefiting from a reduced, or zero in some cases, rate of tax. This is known as dividend rotation and is practiced by several mutual funds such as The Alpine Dynamic Dividend Fund (ADVDX).

Going into the future

Unfortunately the current, Socialist leaning Obama administration and the Democrat controlled U.S. Congress, do not seem to have the little guy in mind who works hard to make his living, preferring instead the socialist income redistribution model which has failed time and time again all over the world. So after December 31st 2010 the qualified dividends will go away and dividends will be taxed as ordinary income at a much higher tax rate then the current qualified dividends. Just wait till the nitwits in Congress get their hands on our 401(k)’s and IRA’s as there has already been some very disturbing talk coming out from Washington regarding that, but that’s another topic.

The table below shows the dividend tax details for different tax brackets.

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